Tax deal was gain for Black & Decker, loss for IRS

January 18, 2004|By JAY HANCOCK

ON NOV. 25, 1998, Towson-based Black & Decker Corp. swung a complex deal that shifted $562 million in cash and nearly as much in employee medical liabilities to a subsidiary called Black & Decker HealthCare Management Inc.

The next day was Thanksgiving. Almost everybody involved in the transaction had much to be grateful for.

Accountant Deloitte & Touche, which designed the deal, stood to reap at least $2 million in fees from Black & Decker, according to a contract and an invoice on my desk.

Benefits adviser Mercer Consulting, a minority investor in Black & Decker HealthCare, added roughly $1 million a year in fees to its already lucrative relationship with the Towson toolmaker, a Black & Decker memo shows.

And the maker of SnakeLight flashlights, Firestorm drills and DustBuster vacuum cleaners ladled on the most turkey and gravy of all. Thanks to the Deloitte deal, Black & Decker added about $180 million to its bottom line over several years.

One party affected by the transaction, however, had no blessings to count and was not at the table that day.

Black & Decker's gain was the government's loss. The creation of Black & Decker HealthCare and a subsequent sale of stock in the subsidiary created a half-billion-dollar capital loss that the parent company deducted from its taxable profits - saving about $180 million in federal taxes, according to Herbert Odell, a Philadelphia lawyer representing the company.

Well, the government eventually came to the table. And to the judge's bench. And inside Black & Decker itself.

In November 2001, a team of nine Internal Revenue Service officials descended on Black & Decker's headquarters and began what would be a long audit of the company's tax returns, legal papers show. Several took up permanent office space in Towson, and the team finished up only a few months ago.

Such an examination is not unusual. About three-fourths of the 1,600 biggest U.S. businesses are being audited at any given time, says Larry R. Langdon, who stepped down last year as the IRS commissioner for large- and mid-size businesses, although he says an audit team of nine is "a tad large."

What was unusual was the audit's result. The IRS deemed Black & Decker HealthCare to be an abusive tax shelter and, the company disclosed a few weeks ago, is seeking a whopping $140 million in unpaid Black & Decker taxes. The agency has also denied tens of millions more in related tax refunds sought by Black & Decker.

The scheme sure looks abusive. Pay attention, because you're about to see how $180 million in tax revenue can disappear with the shuffle of a few papers.

To create a large, tax-deductible capital loss, Black & Decker first "bought" stock in Black & Decker HealthCare for $562 million in cash, simultaneously assigning the subsidiary about the same amount in employee medical liabilities.

Then Black & Decker borrowed most of the cash back from the subsidiary and sold the stock to Raymond DeVita, a retired Black & Decker executive, for about $1 million.

Bingo: The sale created a $561 million "loss" on Black & Decker HealthCare stock. Black & Decker and an affiliate still held most of the health unit's board seats through other classes of stock. It still was on the hook for the medical liabilities. It held onto most of its cash.

But it had an enormous tax deduction.

Black & Decker denies that the deal was abusive and is fighting the IRS in court. The need to control medical costs, the company says, created a legitimate reason to set up Black & Decker HealthCare.

"It was implemented as a business transaction with a tax benefit as well," says Odell, Black & Decker's attorney. "Black & Decker had a real business purpose for what they did."

DeVita, the company says, is an independent investor, and his purchase of Black & Decker HealthCare stock was an arm's-length transaction.

But DeVita wasn't independent enough to speak with me when I left a message at his house in Naples, Fla. He immediately called Black & Decker's public relations department, which said he declined to comment.

Mercer Consulting has been working for Black & Decker for years, but Mercer, too, is painted as an outside party "motivated by investment considerations" in the transaction.

Gee, Mercer consultant Charles Habliston had a different answer when he was questioned last year by an IRS lawyer.

"In my opinion, why do the deal?" he said, according to a deposition transcript. "To maintain our relationship with Black & Decker."

(The idea was that, by owning stock in Black & Decker HealthCare, DeVita and Mercer would be motivated to help Black & Decker cut medical costs so they could increase the value of their stakes.)

Odell says the IRS changed rules in the middle of the game, claiming that a 1995 agency ruling allowed the kind of "contingent liability" tax shelter Black & Decker employed.